The topic of this article is profit targets. Do you need to use them and how they can actually make you a more consistently profitable trader?
In our opinion, too many traders focus on getting involved in a profitable position but not the same amount of focus goes into sustaining profits once they have been made, as quite often many retail traders actually end up giving profits back to the market in the long-term. How do trader’s end up giving back profits to the market you may ask? There are two answers for this question.
The trader has never learned how to use profit targets to their advantage and instead over reaches on what is actually achievable for one single trade in terms of how much profit can be made.
The trader knows exactly how to use profit targets when involved in an open position and may even set the profit target. However, something may occur for which only the trader can control and that is emotion, as too many times emotions ruin good traders as they allow their emotions to dictate their action. One single emotion that ruins retail traders time and time again is greed.
In our opinion here at Fair Exchange, your profit target should be decided before you ever execute a live position as you need to know your exit point out of the market so that you do not need to react in the moment and allow opportunity for greed to set in and take over through that of your emotions controlling your decisions.
It is vital that you always remember that you never know what the market will do next in the short-term perspective hence why we speculate on price movements and do guarantee them but traders often forget this aspect and instead when a position goes in their favour they sometimes believe that they know better than the market and this leads into over confidence to sometimes bordering arrogance. The problem with this is when you become arrogant and believe you can always predict what the market will do next and while you may have a short winning streak it won’t last forever and when it begins to turn bad you will become stubborn and not accept the fact that you are wrong, which will result in you not being accountable for your actions.
A profit target is a price level set through a sell or buy limit order that when filled closes your position in a profitable state. It is simply the reversed roll of a stop-loss.
So why is a profit target essential in your quest to be a consistently profitable trader? Simple. Your aim is to be a profitable trader meaning that you need to retain profits and not give them back to the market and so a profit target will allow you to exit a position that was profitable and stops you from becoming over confident with yourself/arrogant where your emotions controlling your decisions. Along with this, it allows you to establish a realistic exit point in the market, as we are simply speculating on price movements and therefore this can be quite subjective, but by using technical analysis in our trading we can predict where prices are likely to go through that of identifying confluences i.e. reasons that align with one another suggesting a specific price in the market rather than a pure prediction.
An analogy often used to describe how you should manage your profits is that of a cookie jar and not being caught, as it is better to take one cookie at a time and not being caught to then have the ability to go back again for another cookie than trying to take the whole jar as the risk is much higher for being caught.
Along with being a profitable trader, you also want to be consistent in being profitable in the long-term perspective, correct? So, if you are wanting to be consistent how do you think you become consistent? The answer is through consistent action because consistent actions lead to consistent results. Therefore if you set profit targets, every time you execute a position this will assist you in becoming a consistently profitable trader and the reason for that is because you are removing subjectivity from your trading. Trading is very subjective as you are simply interpreting what you are looking at on the chart to form an opinion on what might happen next and if we have subjective behaviour in our trading this will lead to inconsistencies and emotional trading. This is the reason for why we use a rule-based approach as by doing so we can reduce the amount of subjectivity that is surrounded when we are speculating on what might happen next because if a profit target is fulfilled at that point you have two potential options;
You are automatically triggered out of the market for a profit dictated by where your entry price is to that of profit taking price and the position is at that point closed and at that point you walk away from the trade and look for a new setup to enter.
You could look for extended profit targets/Target 2’s and at that point you could roll your stop-loss past breakeven (entry price of the position) to lock in and secure a fixed amount of profit and with your speculation, price can push further in your favour to allow a greater yield for the same position and also use a rolling stop-loss (when price moves in your favour you move your stop-loss accordingly to further lock in profit).
Regardless of which approach you use for profit taking, either way you will not lose money because the worst-case scenario is that you move stops to breakeven when T1’s are fulfilled and you decided to shoot for secondary targets but in the process are stopped out of the position. However, you have not lost any capital as your stop is at that point at your entry price.
The most important reason that as a trader you should be setting profit targets for every trade and prior to entry of any position is confidence. If you were to go long on EURUSD at 1.5050 and believe prices could extend up into highs of 1.5100’s and your reasoning behind the potential move is simply because you think it can, do you believe this is a good enough reason to enter a position? Of course, your odds of being right are 50/50 but when you are involved in the trade and prices are not going in your favour do you think you will have the same confidence as what you once did? The answer is probably not and what will happen next as your position begins to move into a loss is that emotions will begin to heighten such as; fear, panic and anxiety as the trade moves further into a loss and the reason behind that is because you do not have the confidence in your analysis to support your reasoning for why price could move in your favour as it was nothing more than speculation. What happens next is that as prices continue to move into a loss is that that you will close the position before your stop-loss is triggered, if you use one, but that is a different conversation for another time. The problem with this approach is that regardless of the outcome, the trader will believe he is correct either way and his action was the right one to make. For example, if the trader was to close the trade in a minor loss and prices continue to decline he would simply praise himself because he made the correct decision to close early and did not take a bigger loss for what he could have taken. Contrary to this, if prices were to go in his favour after closing he would say something such as this ‘I knew price would go up to 1.5100’s and I was right all along’. Well if you knew prices would go up to 1.5100 why did you close the trade? Simply, he lacked the needed confidence to hold the position when prices went slightly against him and emotions would have taken control, therefore he would not be making rational decisions but rather irrational. The problem with inconsistency in both your behaviour and actions is that it will be hard to pin point your rights from wrongs and it will always end with ‘next time it will be different’. However, the reality is that indeed it will be different but not for a positive result as the outcome will be the same in that your inconsistent actions and method to how and why you enter trades will be inconsistent and inconsistent actions lead to inconsistent results.
A profit taking level is indeed an exit point out of the market but it goes deeper than just that as it is how you identify such an exit point in the market through your analysis that will give you the needed confidence to hold the position if prices goes against your prediction. Our approach to our trading is as we have stated before, to use confluences we identify in our analysis to support our reasoning for where prices may go and why so that we can build both discretion and confidence into our trading.
Our job is to predict what might happen next by reading price action and identifying other reasons that support the same idea so that we have an edge.
Now for the same example instead of speculation on opinion you conduct technical analysis and you find a number of confluences supporting your reasoning for prices to extend up into 1.5100’s such as; identifying a major level of structure resistance up at 1.5050 along with a 1.272 Fibonacci extension, an ABCD (equal measured move) pattern and the even handle of 1.5100. Therefore, you have identified four separate confluences in the market suggesting reasons for why prices could press up into 1.5100 but could suggest a potential reversal in EURUSD up at that area in the market and as a buyer it would be a sensible place to exit this buy position. However, more importantly than just identifying a strong exit price in the market if the trade goes in your favour you would have also built direction into your analysis as you have been able to find multiple reasons for why your analysis of price could play out in the market. Therefore, when involved in a live position and you have this needed confidence and discretion in your analysis, when prices go against you, you will have the ability hold the position more so than if you didn’t and if the profit target is fulfilled you know at the point it would be a sensible decision to either exit the market for full profit or move your stop-loss to breakeven to take risk off and use the same analysis once more to identify target 2’s.
However, you still need to have realistic expectations for what is achievable for one single trade, as mentioned before, because when you do use profit targets it does not equal certainty for a trade as it is simply a tool used to identify an exit point out of the market to remove decision making when your emotions will be heightened. For example, if you see an opportunity for EURUSD to rally from your analysis on the Daily TF and execute a position from a setup on the 5M TF then you need to understand what can be realised from one single trade, as it is very unlikely that you will realise full profits of your daily analysis from a position on the 5M TF due to the volatility and momentum in prices.
We hope that this helped you to understand why profit taking levels are so important in your trading not just for identifying an exit point in the market but allowing you to build both discretion and confidence into your trade as you find reasons to support your hypothesis of price.
Fair Exchange FX.